Corporate Finance Proctored Final Examination Exam Number 500305

Question 1

You complete an analysis of a new project, and the NPV is $1. You recommend that the project be accepted. Your coworker from marketing argues that the project should not be accepted because the NPV of $1 isn't enough for a profit. Assuming the discount rate is indeed conservative, how do you respond in the following scenarios? Which project(s) should be accepted or rejected?

a. There are not any mutually exclusive projects.

b. Your coworker has an idea for another mutual exclusive project. You calculate the NPV at the new project to be $2,

c. Your coworker has an idea for another project. You calculate that the NPV of the new project is $2. The projects are not mutually exclusive.

 

Question 2

What is the difference between marginal and average tax rates? How can you determine the average tax rate? What's most important for most financial decisions?

 

Question 3

Describe how the dividend growth model values a stock. Why isn't it a good idea to use the dividend growth model for growth stocks?

 

Question 4

You have invested in a small, but rapidly growing company that's starting to generate good cash flows and is becoming very profitable. The company is currently 100 percent equity-financed. Using the formula for WACC, explain why it might be a good idea to use at least some debt financing.

 

Question 5

What happens to bond prices as interest rates increase? Why?

 

Question 6

Recall that the security market line (SML) illustrates the relationship between systematic risk and expected returns. Perhaps the most famous formula and practical application of the SML is the capital asset pricing model (CAPM), expressed as follows:

 

E(R1)=Rf+{E(Rm)-R1}*B1

 

A. explain each of the variables

B. describe B1 in more detail, including its effect on the expected return on the investment. What would a beta of 1.5 suggest?

 

Question 7

You're a consultant hired by a small company that installs GPS units in semi trucks and school buses. the company is considering investing in a project to manufacture the units themselves (instead of purchasing the new units). they've used their weighted average cost of capital (WACC) of 15 percent to determine that the project has a positive NPV of $3,000.

 

The CFO and CEO don't agree. the CEO doesn't believe that the WACC is the correct number because the project is risky: its a brand-new venture. The CFO argues that the WACC already incorporates risk, and the cost of new funds at the source (debt and equity financing) is the only thing that matters.

 

A. what is WACC? what's the formula? Who is correct? why?

 

B. What are two different approaches to determine an appropriate cost of capital that appropriately accounts for the different risk? Walk us through the steps in how you would you proceed. (keep in mind three's more than one correct answer) then identify an advantage and disadvantage of each of these approaches. Lastly, how would you determine if this project should be accepted or rejected ? (no actual computations are needed)